When the Bank for International Settlements (BIS) calls central bank market rigging “the fairy dust of illusory riches,” it’s time to pay attention.
The BIS is the central banks’ central bank. Its role is “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.”
To provide the statement with some context, and to alert you about what else you can expect from central banks moving forward, we provide a summary of other key points made in this year’s BIS annual report, which is appropriately titled, “In Search of a New Compass.”
First, there’s recognition that easy money policy has gone far enough. That’s self-evident, but of special interest when you consider the source. BIS notes that despite a pickup in economic growth, the world economy “has not shaken off its dependence on monetary stimulus. Monetary policy is still struggling to normalize after so many years of extraordinary accommodation.”
Of course, it’s the central bankers who are struggling to “normalize” monetary policy – policy can’t normalize itself – but you get the point.
The BIS even notes that “monetary policy is not the best tool for boosting demand and hence inflation.” The Federal Reserve Board must have missed that economics class, since a major goal of its bond buying has been to boost the U.S. inflation rate to 2%.
Next, the BIS says that “despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions. And despite lackluster long-term growth prospects, debt continues to rise.”
While shifting the blame to large firms, these are points worth making. But maybe if central banks hadn’t pushed interest rates to near zero, debt wouldn’t be rising so rapidly. Who can resist nearly free money?
While the report repeatedly mentions growing debt as a problem, it includes government debt, not just private sector debt, in its criticism.
The New Compass
While acknowledging the need for a “new compass” to replace monetary policy, the BIW report falls short of providing one, but does make a number of recommendations.
The BIS suggests that “exchange rate depreciation can help,” but “it also raises awkward international issues.” Currency wars can be so awkward! Not to mention counterproductive.
Instead of further monetary accommodation and currency manipulation, the BIS suggests that focus shift to “removing the obstacles to growth,” adding that “raising productivity growth is the only way to boost long-term growth.”
While policies to raise productivity may vary from country to country, BIS says “it will frequently include deregulating protected sectors, such as services, improving labor market flexibility, raising participation rates and trimming public sector bloat.”
Reducing regulation on business and cutting government spending can boost growth! Imagine that!
One drawback of bond buying, as we’ve frequently noted, is that once it starts, stopping it can be tricky and can lead to further economic problems, as well as market disruptions.
The BIS writes that “regardless of central banks’ communication efforts, the exit is unlikely to be smooth. Seeking to prepare markets by being clear about intentions may inadvertently result in participants taking more assurance than the central bank wishes to convey. This can encourage further risk-taking, sowing the seeds of an even sharper reaction.”
The phrase “further risk-taking” is an accurate summary of the current market.
“The risks of failing to act should not be underestimated,” the BIS concludes. “The global economy may be set on an unsustainable path. And at some point, the current open global trade and financial order could be seriously threatened.”
It’s time to clear away the fairy dust. But will the Federal Reserve Board and the U.S. government heed the BIS’ warning?